Should I take out a reverse mortgage?

By Walter Updegrave, senior editor

(Money Magazine) -- My wife and I are 62 and just starting to take Social Security. We're thinking about taking out a reverse mortgage and using it as a line of credit. The extra money could come in handy. What do you think? -- S.W., Red Oak, Texas

A reverse mortgage can be a good way for people 62 and older to turn their home equity into extra spending cash that can supplement Social Security and withdrawals from savings, making retirement more enjoyable than it otherwise might be.


Typically, you can take the loan proceeds in a lump sum, monthly payments for life, as a credit line or a combination of these.

One of the big appeals of this type of arrangement -- as opposed to, say, tapping your home equity by refinancing or opening a home equity line of credit -- is that you don't have to repay the loan until you die or move out of your house.

Another plus is that the payments you receive from a reverse mortgage don't affect your Social Security benefits (although they could affect your eligibility for programs like Medicaid and Supplemental Security Income, or SSI, the program that provides income to people with low incomes and disabilities).

Until recently, though, there's been a practical problem for anyone who, like you, plans to use a reverse mortgage primarily as a line of credit that could be drawn upon when and if needed, versus taking out a large amount for some immediate need (renovating a home, replacing a car, whatever).

That problem: In addition to interest expense and an annual insurance charge (now 1.25% a year) on the outstanding balance, the Department of Housing and Urban Development's popular Home Equity Conversion Mortgage reverse mortgage program (aka HECM Standard) also levies an initial one-time insurance premium of 2% of the value of your home.

That amounts to $6,000 for a $300,000 home. You don't have to pay this charge out of pocket. Still, it boosts the overall cost of borrowing, and can significantly drive up the effective annual interest rate you pay if you wind up drawing very little against the reverse mortgage or if you die or move from your home shortly after taking out the loan.

But in October, HUD unveiled a new reverse mortgage program, known as HECM Saver, that whittles down the initial insurance premium from 2% to 0.01% of your home's value, reducing that one-time charge from $6,000 to just $30 on a $300,000 home.

You'll still incur interest charges and the annual insurance fee. But by lowering the upfront cost, the HECM Saver potentially makes a reverse mortgage a more viable option if you intend to use it primarily as a back-up line of credit or an emergency fund, or if you think you will use it sparingly or not remain in your home for many years.

I say "potentially" for two reasons. For one thing, you'll still have to pay closing costs on the loan, which can include such expenses as an appraisal, title search and insurance, credit checks, mortgage taxes and a loan origination fee.

Lenders can charge an origination fee of as much as $2,500 if your home's value is less than $125,000. If your home is worth more than that, lenders can charge 2% of the first $200,000 of your home's value plus an additional 1% on the amount over $200,000.

That translates to a $5,000 origination fee on a $300,000 home. (The origination fee is capped at $6,000.) As my MONEY colleague George Mannes noted previously, some lenders may be willing to waive origination fees and pick up a portion of other upfront costs, such as the initial insurance premium.

Even though you're not paying upfront costs out of pocket, they're still part of the cost of borrowing and will increase the effective interest rate on the loan. So you'll want to take a close look at however much you're being charged upfront and decide if that amount makes sense given the likely amount you'll be borrowing.

You should also know that because it levies a lower initial insurance premium, the HECM Saver doesn't allow you to borrow as much as you can with a HECM Standard reverse mortgage.

For example, a 62-year-old who owns a $300,000 home with no mortgage debt might qualify for just under $102,000 with an adjustable rate HECM Saver.

Under the HECM Standard program, that same person might be able to borrow almost $141,000. (To see how much you might get under each program given your age, where you live and the market value of your home, check out AARP's reverse mortgage calculator.)

No matter how enticing getting money on the house might seem, remember, a reverse mortgage isn't something you should take on lightly. As part of the deal, you're required to pay homeowners insurance premiums and property taxes. You must also maintain the property in good condition.

Fail to do so, and you could be forced to repay the loan even if you're still living in the house. If you don't have other resources to do that, you would have to sell. So before signing up for a reverse mortgage, consider whether there are other options for you and your spouse.

In some cases, retirees can be better off tapping a cash-value life insurance or freeing up their home equity by downsizing to smaller or less expensive digs that have lower ongoing maintenance and utility costs.

Fortunately, HUD has beefed up the mandatory no- or low-cost counseling that borrowers must get before taking out a reverse mortgage.

And to help people considering a reverse mortgage more fully understand the pros and cons of such a loan, counseling agencies must now provide potential reverse mortgage borrowers with a packet of information before the counseling session, including material for assessing these loans' true costs and a booklet from the National Council on Aging that outlines how reverse mortgages work.

Remember too that while HECM reverse mortgages are insured by the federal government, the loans themselves are made by private lenders who do not set identical terms.

So compare the offerings of several lenders before settling on a loan. You can find tips on choosing the best loan by clicking here. I also suggest you peruse the material on the reverse mortgage section of AARP's site.

Finally, a recent Consumers Union report contends that some unscrupulous reverse mortgage lenders push these loans on people who might be better off without them or even use reverse mortgages to perpetuate various financial scams.

I've also warned about such abuses as putative advisers recommending reverse mortgages and then persuading borrowers to invest the money in high-cost investments like annuities. So certainly, you and your wife should look into a reverse mortgage as a way of getting some extra income.

But don't commit until you've thought about other options, you understand all the costs and you're convinced that the person making the loan is on the up and up. To top of page

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